I finally figured out how to zero out my taxes using TaxAct. I consider doing a tax return a game that expensive accountants and their clients play in order to create either a zero tax return or even better, to get a refund. I figured that I just needed to continue playing with TaxAct until I owed zero tax. That way I could just send my 2010 and 2011 retunrs with the completed Form 8854 and be done with the IRS, once and for all time. My problem is that nearly half of my income is unearned, passive income that is not counted in the Foreign Earned Income Exclusion (FEIE).
Remember in my last post, I couldn’t get a zero return because I was trying to apply either the FEIE or the Foreign Tax Credit (FTC)? Well I realized that I’d probably get a much better result if I applied both/and rather than either/or. So this is what I decided to do.
- I applied the FEIE to the 50% of my return which is earned income. This takes income right off the top of the tax return. The reason that probably I still owed taxes when I applied only FTC but not FEIE was that my income for US tax purposes was too high, jetting me into a higher tax liability. By applying the FEIE, I reduce my gross income by 50%. All that remains is passive income.
- One problem is that you may not claim the FTC on tax on earned income that benefited from the FEIE. But how do I calculate how much of the taxes that I paid in Canada was for earned income and how much was for passive income and can thus count for the FTC? Since my Canadian Notice of Assessment does not distinguish between taxes paid on passive (unearned) and earned income, I decided I would pro rate the Canadian tax. Thus I used the following formula: p=passive income reported on CDN return; e=earned income on CDN return; i=gross income CDN return; y=taxes paid in Canada. p=i-e; FTC=y*(p/i). This came to about 42.8% of the taxes paid in Canada on the Notice of Assessment. Then, I added this using TaxAct, Form 1116 (use manual setting, selected foreign tax on passive income category). Can anyone see anything wrong with this calculation?
- I figured out how to apply interest carry charges to my investment income. There is a category for this in deductions. Once I did these things (1-3), I had a taxes due at $667. Success! I just need some more deductions and then we’re there.
- I added charitable contributions to my local church, which is a recognized charity . According to the Tax Treaty, the IRS should thus recognized it as a charitable contribution. This was the coup de grace which finally killed the IRS beast of a tax liability for my 2010 tax return. Now I go to print, do RRSP forms, etc.
I would appreciate any comments or objections to what you read here. As I say, this whole tax thing is just one big game. In principle, I believe I should have to pay zero taxes to the IRS. Therefore, I’ve tried to play the Form Nation game in such a way as I don’t lose.
Now everything that I’ve done is reasonable. It may not be allowed. But as I said, if the IRS doesn’t like it, they will have to collect what they think I owe them through the CRA. Since the principle of the FTC is that a person not be subject to double taxation, my return is within the spirit of the law, if not the letter. I will never send a cheque to the IRS directly. I may even send a cover letter saying to them that they can challenge and audit my returns all they like, but if they want to collect, they will have to use the provisions in the Canada US tax treaty and use the CRA to do their dirty work for them. I think those of us in Canada need to present a high level of resistance and make the IRS understand that we are not the low hanging fruit. Then perhaps, they will spend their resources trying to collect on people who can’t resist them because they live within the boundaries of their jurisdiction.
UPDATE: I have recalculated the percent of tax on passive income by providing the numbers from my Canadian tax return for total gross income (which includes adjustments for Canada eligible dividends and 50% only of capital gains). The resultant percentage of tax on passive income is 42.8% instead of 50% (based on higher numbers for passive income reported in US return). This increased the tax calculations before charitable gifts from about $200 to $667 because of the lower Foreign tax credit. The charitable gifts however wipes out taxes owed in both cases.